Speeches

Economic Outlook

Remarks before the Philadelphia Chamber of Commerce
Philadelphia, PA
January 8, 2002

Introduction

Good morning. It is a pleasure
to be with you to talk about the economic outlook for the
nation and for our own Greater Philadelphia area. When we
last convened, we discussed the evolution of the longest
economic expansion in U.S. history. Now one year later,
I return to talk about recovery from a recession. Times
have indeed changed.

Today, I would like to share
my thoughts on the impact of recent events on the national
economy, and how this affects our national prospects for
future economic growth. I will also talk about developments
in and around the Greater Philadelphia area, and what is
needed to spark a regional resurgence.

The national economy is
in the midst of recession

Late last summer, the economy
was struggling to revive growth from the precipitous slowdown
that began in the fourth quarter of 2000. Then came September
11. Already low growth rates turned negative and the nation
finally fell prey to recession. Some months later, recession
was officially declared by the NBER, the authority on such
measurements. While the formal start of our 10th post-war recession was dated March 2001, it will forever
be associated with the September 11th attacks.
The post-9/11 economic impact became readily apparent in
real GDP figures: real GDP growth for the third quarter
of 2001 is now estimated at -1.3% and fourth quarter growth
is forecasted to be negative as well. This --- the first
recession since 1990-91 --- officially brings to a close
the longest period of post-war economic expansion in American
history.

The
consensus view is that recovery will begin in the first
half of 2002

Economic
recovery is widely anticipated to begin in the first or
second quarter of 2002 according to the median forecast
from our Survey of
Professional Forecasters. Given that past recessions
have averaged about 11 months in duration, this makes sense
from a cyclical perspective. I concur that recovery is pending.
However, based on my own analysis of recovery criteria and
the risks we face, I believe recovery will occur around
mid-2002 - a few months later than the median forecast predicts.
In fact, most professional economists are moving toward
this view given the obstacles that have turned up along
the road to recovery.

Reason
for confidence: Substantial monetary and fiscal stimulus
are in the pipeline

Nonetheless,
we can all be confident recovery is on the way. One reason
for such confidence is our country has the biggest stimulus
and lowest interest rates we have had for a very long time.

Fiscal
policy, as captured by the projected federal budget, has
changed dramatically in this cycle. The stimulus associated
with greater government spending and lower taxes should
have a significant positive impact on the economy. The government's
package is expected to equal over $200b, or roughly 2% of
GDP. Government action has resulted in a rapid response
package covering clean-up, airline bailouts, security and
selected tax cuts. Beyond this, the economic stimulus discussions
currently underway may offer an additional boost to beaten-down
sectors of the economy - such as tech - and encourage these
sectors to increase investment spending.

On
the monetary policy front, as a direct result of aggressive
Federal Reserve action, interest rates are at levels not
seen for over forty years. Since January 2001, short-term
interest rates dropped 475 basis points. It has only been
one year since the first rate cut, and it is important to
remember these rate cuts continue to work their way though
the economy. Our aggressive easing policy should have begun
to work by the fall, and I am on record indicating that
the stage was being set for a second half recovery in 2001.
However, this action was suspended due to the attacks. The
economy is valiantly trying to find its footing. In the
meantime, our rapid-fire rate cuts have gone a long way
toward strengthening consumer spending, which should keep
the current downturn mild and brief.

As
a result of these fiscal and monetary activities, the economic
landscape is beginning to resemble pre-attack days in one
important way: It is beginning to give mixed economic signals.
This is a good sign, and an indication that the economy
may be preparing to resume growth.

The
pattern of recovery will be typical, but its pace will be
a slower than usual

For
this recovery to proceed as planned, certain conditions
must be met: decumulation of excess inventories, retention
of consumer confidence, increased business investment spending
and a stable world economy. These criteria involve risks
that may complicate recovery.

First,
the build up of excessive inventories at many levels
of the distribution chain has been a key part of both the
manufacturing recession and tech contraction. Now, businesses'
liquidation of excess inventories  a crucial first step
to recovery  is well along. In fact, businesses' inventory
reduction totaled a record $61.9 billion in the third quarter
of 2001. We do not yet feel the effects on new orders, but
this decumulation is paving the way for increased production
and a revival of the hard hit manufacturing sector.

What
are the roadblocks to recovery? First, the decumulation
of inventories, with the exception of autos, may take longer
than planned. Anxiously awaited fourth quarter retail sales
will likely be lower than hoped, still reflecting the shock
of 9/11. And, although we have seen substantial inventory
adjustment throughout 2001, due to the slowdown in sales
the inventory-to-sales ratio may not have declined as much
as necessary. Second, inventory restocking is predicated
on expected sales growth, and I sense a rather cautious
business sector. Therefore, I believe firms may replace
their depleted inventories more slowly than usual. Then
there are vehicle sales. In the auto sector, most expect
the high year-end sales figures were the result of pulling
sales forward from 2002. It is unlikely inventory restocking
here will occur anytime soon.

But, consumer spending should remain strong into the spring.
The consumer has proven surprisingly resilient throughout
the current slowdown. Retail sales, while down since 9/11,
have been better than expected. The durability of the housing
market is further testament to consumers' unwillingness
to cower from a weak economy. Current weakness is viewed
as transient, which bodes well for recovery. Looking ahead,
low interest rates, low energy prices and the recovery in
the stock market since 9/11 should all work to bolster,
or at least sustain, consumer spending.

The
roadblock can be stated simply: Consumers must be employed
to spend. Softness in the labor markets could put pressure
on consumer spending and affect confidence going forward.
If sharp job losses persist, consumers may retrench, making
the recovery slow and potentially more painful. That said,
we should remember that unemployment is a lagging indicator.
It is likely that unemployment numbers will still be on
the rise as the economy begins its rebound. But as long
as consumers keep the faith, the recession could be mild
and short-lived.

However,
for the economy to move from recovery to sustained expansion,
we will need healthy growth not only in consumer spending,
but in business investment spending as well. Indeed, the
sharp decline in business investment spending was
the number one contributor to this recession. Historically,
when overall economic growth accelerates, it is usually
led by consumer spending, and then amplified by business
investment. So, I do not anticipate a recovery in business
investment spending until the second half of 2002, but it
must at least stabilize and not be a drag on economic growth.

A
potential roadblock here is overcapacity in the technology
sector. The sudden collapse in business investment spending
was, in large measure, the bust following the late 1990s
boom in the tech and telecom sectors. These sectors are
still plagued by overcapacity. For example, analysts estimate
capital spending in the telecom industry will fall $58 billion
in 2002 from its peak of $98 billion in 2000. However, a
bottom to this process appears in sight.

Finally,
the rest of the world

It
is important to remember that the U.S. economy does not
operate in a vacuum. As we entered the new millennium facing
economic decline, some of our European trading partners
argued that the U.S. growth slowdown had little impact on
their short-term performance. Our friends to the south and
east knew better, however, and anticipated the contagious
decline in world economic activity. Now, with our fates
closely aligned, or at least clearly recognized, we are
well aware that the prognosis for growth in the U.S. is
related to recovery elsewhere. At this moment, with one
or two exceptions, the world economy seems well poised for
growth in the coming year. Foreign economies, as far as
Asia and near as Central America, will add to the recovery
picture for the U.S. economy in 2002.

But
risks, or roadblocks as I have been calling them, are present
here as well. Japan must act upon restructuring plans to
end its current recession, and Argentina must contain its
instability. Finally, but most importantly, it is imperative
that growth accelerates in the Eurozone. Anything less will
slow U.S. recovery.

Recovery
by mid-year is very likely, but not yet certain

In
short, a number of sectors will need to transition before
we can be confident of an acceptable level of economic activity.
In the near term, we will be watching indicators like holiday
retail sales, employment, consumer confidence, new orders
in the manufacturing sector, foreign growth estimates and
business inventory levels to see that recovery is on track.

Future
Fed actions will be based upon careful analysis of incoming
information, new developments, and the realization that
monetary policy continues to have long and variable lags.
During transition periods such as this it is important to
recall this last adage. Actions taken today will alter economic
performance in the second half of 2002 at the earliest,
so caution must be the watchword in the months ahead.

As
with any forecast, uncertainty remains. Of course, a key
uncertainty here is progress in the war on terrorism ---
a risk on which it is impossible to put a probability. The
world has changed, and although consumers and businesses
have adapted surprising well to the new realities, there
is still much left to discover. Unforeseen developments
in the war on terrorism could delay a recovery, just as
the speed of the war has buoyed the world economy and hastened
the recovery. Given the uncertainty, we must remain flexible
and open as to what is required going forward.

The
regional economy

In
my remaining time with you I would like to turn attention
to our own backyard. How will our region fare in the year
ahead? Let me say that I expect Greater Philadelphia to
be a full participant in the national recovery and expansion
I foresee this year.

The
past few economic downturns have hit our region harder than
the nation as whole. We tended to slide into recession sooner,
decline more sharply, and recover later than the rest of
the country. Now that seems to be changing. Thus far in
this downturn, we are running on an even keel with the national
economy. Employment decline in our region was simultaneous
with the national decline. This closer alignment of Greater
Philadelphia's economic performance with the nation's is
a result of our region's evolution from a manufacturing
based to a more service based economy. This bodes well in
a new economy that favors the service sector.

Please
read it. There is good news inside. You will find that Greater
Philadelphia compares favorably with the nation and many
other large metropolitan areas in some important economic
measures. Our region's concentration in knowledge industries,
primarily health care, education, biotech and pharmaceuticals,
has made us less susceptible to unemployment in economic
downturns. This partially explains the fact that the unemployment
rate of the Philadelphia Metro area, currently at 4.4%,
is well below the national rate of 5.8%. Nearly one-third
of Philadelphia's workforce is now in knowledge occupations,
that is, requiring formal education at the Bachelor's degree
level or higher. Due to the higher earnings of these knowledge
workers, our 1999 per capita income in the Philadelphia
metro area was 14% above the U.S. average.

Philadelphia's
strength as a tourist destination, also, acts as a catalyst
to bolster the region's economic prospects. Our economy
has already gained strength from a large number of construction
projects, including two new sports stadiums and the renowned
new Kimmel Center for the Performing Arts. In addition,
an aggressive new advertising campaign to promote tourism
has been launched.

As
our region's economy continues this evolution, I think this
bodes well for the future of Greater Philadelphia in the
years ahead. We will continue to benefit from growth in
the service industries, including education, pharmaceuticals
and tourism and move more in sync with the national economy.
Therefore, the national economic recovery I expect by mid-year,
should also bring a turnaround in the region.

Admittedly,
the job growth in the early stages of the recovery will
probably not be strong enough to keep both the national
and regional unemployment rates from rising into the second
half of 2002. But by year-end, activity growth should be
healthy enough to start bringing down unemployment rates.

Conclusion

To
summarize, I see 2002 as a turnaround year. Thanks to the
progress we have made in recent years, the Greater Philadelphia
region will recover along with the nation. We should see
clear signs of renewed growth by mid-year, and a healthy
pace of sustained growth by year-end. Our challenge is to
manage the current period of economic weakness with an eye
to the future. There is no question that business owners
and employees will still face some anxious months, particularly
early in this New Year. But ultimately economic conditions
over the next couple of years will be determined by fundamentals,
and those fundamentals are positive: tame inflation, low
interest rates, and robust productivity growth. Through
it all, we have learned that our economy, like our nation,
is enormously resilient.